Why home prices are approaching their previous peak levels

The FHFA House Price Index differs from the other house price indices like Case-Shiller and Radar Logic in that it only looks at houses with mortgages guaranteed by Fannie Mae and Freddie Mac. This means all the home prices are below the conforming threshold, which is $417,000. It also means the borrower has a mortgage, which eliminates cash-only transactions. And finally, the FHFA House Price Index eliminates jumbos. This makes it more of a central tendency index.

In April, home prices were flat on a month-over-month basis, and they’re up 5.9% year-over-year. Prices are now approaching their previous peak levels.

Real estate values are big drivers of consumer confidence and spending, so they have an enormous effect on the economy. The phenomenon of “underwater” homeowners—homeowners who owe more than their mortgage is worth—has been a major drag on economic growth. Underwater homeowners are reluctant to spend and can’t relocate to where the jobs are. So real estate and mortgage professionals watch the real estate indices closely.

Real estate prices are also a big driver of credit availability in the economy. Mortgages and loans secured by real estate are major risk areas for banks. When real estate prices start falling, banks become conservative and reserve funds for losses. Conversely, increasing real estate prices make the collateral worth more than the loan, which encourages banks to lend more.

Implications for the homebuilders

Rising real estate prices are helpful for builders like Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), and Toll Brothers (TOL) because they make it possible for them to raise prices and increase their gross margins. That said, it appears that buyers are beginning to experience sticker shock, as both prices and mortgage rates have increased markedly over the past year. Builders are noticing a drop-off in traffic, which may mean the days of double-digit average selling prices (that is, ASPs) are over. Investors who are interested in trading the homebuilding sector as a whole should look at the S&P SPDR Homebuilder ETF (XHB).

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